Friday, August 05, 2011

"S&P had held back cutting the rating earlier in the day, after the US government reportedly questioned its maths. But the agency insisted it was cutting America's top AAA rating by one notch to AA-plus, saying the deficit reduction plan passed by Congress on Tuesday did not go far enough to stabilise its debt situation.

This is the first time that S&P has issued a "negative" outlook on the US government since it began rating the credit-worthiness of railroad bonds in 1860.

The dramatic reversal of fortune for the world's largest economy means that US treasuries, once seen as the safest investment in the world, are now rated lower than bonds issued by countries such as the UK, Germany or France."

Editorial:

Upon some reflection, I do believe (or at least hope) that this is a good thing in the long run. In class we harp that the market is a harsh disciplinarian and it will force managers to think long term even when they themselves have a short term horizon. We teach that bondholders may help to monitor firms with free cash flow problems.

This is not that different. Politicians have a short term horizon. And in the absence of shareholders, bondholder really are in the best position to monitor politicians. (Some may argue that the regular elections serve as the most effective monitoring tools, I disagree. Incentive problems and conflicts of interest are too strong here: how often will people vote against money/goods/services going to themselves?)

So it is my hope, that a century from now, history books will look to this day and say, that was the start of the US getting its fiscal house in order. The choices over the next decades will not be easy, but without some market discipline, I fear the necessary decisions would never be made.